S&P Assigns Ratings to Arch Capital Debt

April 30, 2004

Standard & Poor’s Ratings Services announced that it has assigned its “BBB-” senior debt rating to Arch Capital Group Ltd.’s $300 million 30-year senior debt issue announced on April 27. (See IJ Website April 28)

S&P also said it has assigned its ‘BB+” preliminary subordinated debt and “BB” preliminary preferred stock ratings to the company’s $500 million shelf registration as amended Dec. 29, 2003.

“The debt issue is drawn from the shelf,” said S&P. “Proceeds will be applied toward the repayment of the existing $200 million bank debt outstanding and for general corporate purposes. The rating is based on Arch and its operating companies’ very strong operating performance in the past two years; strong capital adequacy, with a robust stock price; and low debt leverage as of year-end 2003.

“Offsetting these positive factors are the risks of capital strain and a potential misstep from the aggressive growth strategy.”

S&P said it “expects debt to capital of 13 percent as of March 31, 2004, with debt plus preferred/capital of 48 percent pro forma as of March 31, 2004,” following the new debt issue.

Commenting on the company’s outlook, the rating agency said, “In the next two to three years, Arch is expected to benefit from its good market position and the absence of legacy problems. Debt leverage is not expected to be more than 20% of capital at the current rating, and coverage is expected to be at or better than 3x-5x. The company is expected to generate positive underwriting results and good return on business written.”

It listed the following as “Major Rating Factors:
– Very strong business volume. Arch has successfully established itself as a competitor in insurance and reinsurance, building a large and diversified business franchise in the past two years.
– Conservative investment portfolio. Arch is invested conservatively, principally in high-quality, short-duration fixed-income assets. Although low yielding in the current interest rate environment, Arch has minimal credit risk in its investment portfolio.
– Strong capital adequacy. Arch’s capital is strong, based on Standard & Poor’s property/casualty capital model.
– Aggressive growth strategy. Arch has grown aggressively since its relaunch in 2001 and 2002, with gross and net premium written up 117% from year-end 2002 to year-end 2003. Growth has stressed capital adequacy considerably, but Arch has been profitable through first-quarter 2004.
– Short track record. As an opportunistic company in both insurance and reinsurance business, management will need to chose its markets carefully, especially as the industry returns to less-strong cyclical periods. Arch’s management’s ability to make the profitable strategic choices with these operations is yet unproven and untested.
– Lower quality of capital. Arch recapitalized in 2001, principally with mandatory convertible preferred shares rather than common shares, with debt plus mandatory convertible preferred shares constituting about 55.5% of the group’s capital base as of Dec. 31, 2003, pro forma for the increase in debt. Arch improved its capital base through net income of $87.5 million and a $179 million secondary equity offering in the first quarter of 2004.

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